Value is a key concept in digital-product innovation. We’re always in the business of evaluating potential benefits to customers, or evaluating concepts to choose the best approach. At the same time, the term “Value” is used extremely vaguely and its usage is frequently debased. In this post, I draw on some simple distinctions and basic equations to clarify this area.
Types of Value
There are certainly many different kinds of Value and ways of creating it that matter to companies. Making progress towards its objectives, mission, and vision is, by definition, of Value to the company. Acting in accord with its “values” is also of Value to the company.
Just because the financial consequences (indirect benefits) of these activities may be impossible to calculate doesn’t mean they are of no Value. It is only that their Value should be assessed qualitatively, rather than quantitatively. Incidentally, it is much better to leave their assessment in purely qualitative form than to force it into a pseudo-quantitative form, although this is often done by decision analysts. When combined with poorly-defined fundamental concepts and simplistic mathematics, planners and decision makers can easily be mislead about the consequences of their choices.
On the other hand, many things of Value to a company that are difficult to estimate—much less calculate precisely—can still be handled very well through more sophisticated means of quantification, such as probability distributions.
The Meaning of “Value”
But before we can discuss complicated types of quantification, we must first get clear about the meaning of Value itself. Part of the difficulty talking about “Value” is that there are many loosely-defined terms used as synonyms for Value or for each other, including
| Value | Exposure |
| ROI | Confidence |
| Worth | Efficiency |
| Benefit | Expense |
| Gain | Cost |
| Reduction in Liability | Total Life-cycle |
| Reduction in Risk | Investment |
| Reduction in Uncertainty | Brand Equity |
There isn’t much hope of establishing solid foundations for this field without carefully defining these terms and clearly distinguishing them from each other. The absence of such clarity is very likely to have been responsible for much of the unsatisfactory strategic planning in the product-development field, causing inefficient projects and less business benefits than could be achieved.
Knowing the Value of each potential product that seizes is a business opportunity is critically important to companies for many obvious reasons. These include
- Choosing the strategy that produces the highest Value
- Demonstrating Value to management, as Solutions increase revenues and/or reduce liabilities and risks
- Increasing Value by finding higher-Value Solutions
Anything that increases present or future profit, however directly or indirectly, has Value to a company. It can be calculated in three distinct ways. The next three parts of this post give the equation for each.
The First Equation for Value
Let us begin with a clear, solid definition of financial “Value,” putting aside the conventional assumptions that tend to confuse the concept. The first, simplest, general definition of Value (V) is
B is Benefit and C is Cost. For example, if the Benefit of $2M of product-development work is that it reduces a $10M liability (say, average monthly cost of unsold hotel inventory for a resort) down to $5M, the Value to the company of this activity is
In many circumstances, calculating Value as B – C is most appropriate, partly because it produces a Value in dollars.
The Second Equation for Value
However, there are other circumstances where a second way to calculate Value is more useful—as a percentage (the familiar cost-benefit ratio):
For example, if you are considering buying one of several computers with different levels of performance and different costs, you can divide each computer’s performance score by its cost to get a measure of its Value in terms of its cost-benefit ratio. Another example, in the area of investing, would be if you invest $100 for a year and it turns into $150, you would say your Benefit was the $50 appreciation or return ®) on your Cost, which was an investment (I) of $100. This produces a 50% Value or Return on Investment (ROI).
The Third Equation for Value
A slight refinement of this equation leads to a third way to calculate Value, which is more meaningful when the Benefit is not merely appreciation on the principal of an investment (its “Cost”).
For example, if you pay your financial adviser $1,000 to find some better investments for you, and these investments improve your annual income from investing by $5,000, the Value you received from the financial adviser would be
In such cases, you have to subtract the Cost incurred to produce the Benefit before dividing by the Cost to get the true ROI. You took a chance on the financial adviser by paying him/her $1,000, hoping the advice would pay off. When it did, you ended up $4,000 (not $5,000) ahead for the year. This has the same effect as investing $1,000 and having it produce a $4,000 profit or ROI, which is 400%.
Thus, to express a value proposition—often a vague, blappy concept—know that you are really trying to express, usually in verbal, qualitative terms, the benefits over the costs.
